Are Low Equity P/C Ratios an Immediate Cause for Concern

The press and several notable market pundits are using an extremely low Equity Put/Call Ratio as a sign of an imminent market top, but in the past I have noted that the Equity P/C is a component of the smart money in the DM/SM options indicator.  In the past, I have used several examples such as the Nov 2017-Jan 2018 period where the market continued to rally even though the Equity P/C was low.  So today I want to take a more analytical approach with the data mining software developed last summer using the spread of the Equity P/C to CPC Revised (less VIX options) and as shown in the Tech/Other section, a low relative Equity P/C is more often bullish than not.

Over the last couple of weeks I have received a couple of inquiries about my annual long term forecast, but to tell the truth there several political factors, ie, the Trump impeachment, the election, China/Hong Kong developments, and repo problems, that raise major unknowns and make it difficult to consider long term outlooks.  Also this summer, several months were spent in software development where I fell behind in updating the article index and also I want to add a new section to the Investment Diary describing the data mining results, so both of these take priority.  That being said, in the Tech/Other section I will provide an interim outlook, where I think we are approaching a top equivalent to July 2007 that was followed by a 10% correction then a double top in Oct before a larger decline Jan 2008 (18%) and a final failed rally into May before the bottom fell out for the stock market later 2008.

For the shorter term, looking over the SPX charts, I noticed that the rally off the Aug 2015 and Feb 2016 lows at 1810 was a total of SPX 1063 pts to the Jan 2018 highs.  So if this is an ABC rally with Jan 2018 the top of A, Dec the bottom of B at 2347, then a C = A rally should top at SPX 3410.  This matches some of the Fibs I've seen and aligns with the NDX megaphone top at 9200-50 as well as DJIA at 30K.


I. Sentiment Indicators

The overall Indicator Scoreboard (INT term, outlook two to four months) bearish sentiment remains at extreme lows which is likely pointing to a more important top than previously seen on Jan and Oct 2018.

The INT view of the Short Term Indicator (VXX $ volume and Smart Beta P/C [ETF Puts/Equity Calls], outlook two to four months) bearish sentiment showing higher prices followed lower bearish sentiment followed by lower prices.  When will the dam break?

Bonds (TNX).  Bond investors seem to be more fearful of higher stock prices than they are of higher interest rates.  Last week the Trump team announced a possible "middle class" tax cut by reducing earned income and payroll taxes, look for an explosion in the deficit and higher rates if passed.

For the INT outlook with LT still negative, the gold miners (HUI) bearish sentiment not sure what gold bugs are smoking but fate will likely follow that of bond holders.

II. Dumb Money/Smart Money Indicators

The option-based Dumb Money/Smart Money Indicator as short/INT term (outlook 2 to 4 mns/weeks) LT EMAs showing lowest bearish sentiment of last two years that means a ticking time bomb.

And the sister options Hedge Ratio sentiment is freaking me out.

The INT term SPX Long Term (2x/DM) ETFs (outlook two to four weeks) bearish sentiment is looking more like the Jan rounded bottom that may indicate a sharp downturn ahead.

The INT term NDX Long Term (2x/DM) ETFs (outlook two to four weeks) bearish sentiment is similar to the SPX ETF measure.

Finally, the Safety Trade Indicator (SPX/TNX ETFs) shows that bond holders are stubbornly clinging to Gollum's "precious".  One scenario that may work out is a stock consolidation thru the impeachment, a final pop, middle tax cuts go thru, bonds and stocks decline.

III. Options Open Interest

Using Thur closing OI, remember that further out time frames are more likely to change over time, and that closing prices are more likely to be effected.  This week I will look out thru Jan 24. Also, This week includes a look at the TLT for Feb exp.

With Fri close at SPX 3330, options OI starts light but increases during the week, showing heavy resistance over 3300.  The spread SPX puts/ETF calls remains slightly positive. Tue, some weakness may push the SPX to the low 3300s.

Wed has somewhat larger OI where SPX 3320 is the key.  Under that level 3275 is possible, over it, there is little resistance to the upside.

For Fri, large OI may influence weekly behavior where parameters are much like Wed.  SPX 3320 is the key where below it, 3300 is likely, but over, there is only small resistance to 3365.

Using the GDX as a gold miner proxy closing at 28.4.  Last weeks resistance at 30 held, although GDX stayed above the target range of 26-8.

Currently the TLT is 138 with the TNX at 1.84%.  Overlapping straddles at 138 and 140 are likely to keep prices in that range or close to it.

IV. Technical / Other

A. Data Mining Indicator Updates.  First, the Crash Indicator has continued to curl upward after stopping just short of the -2 SD level, and likely indicates a non-crash correction similar to May and Aug of 2019, although likely more severe (10%).

The VIX Call Indicator (spread to CPC Revised) has finally reached an official SELL level with Fri the highest level of calls yet, this means that a sharp decline is likely to start over the next two to three weeks.

And finally, a look at the Equity P/C spread (CPC Revised less CPCE).   The Equity P/C (green) is a component of the smart money in the option-based DM/SM Indicator, and below you can see that the Equity P/C spread (blue) typically reaches its high point prior to a sharp rally, not at the top as many believe and typically sees a decline to neutral or lower at tops.  For instance in Jan 2018, the peak was at the beginning of Jan before the meltup and for the Sept-Oct 2019 top peaked in early July.  Currently the spread is still rising, indicating that higher prices are still likely.

B. Long Term Outlook.  First, a look at the SPX price chart from 2009-20.  I have seen some analyst who look at the tops of rallies since 2009 (mid-line) to show that the SPX is a breakout that indicates several hundred pts higher is likely.  Personally, I prefer to start with the bottoms, since bottoms usually represent stronger sentiment (panic lows).  Drawing parallel lines between the bottoms and the 2007 high currently shows a top in the lower 3400's close to the 3410 mentioned above.  Note the Dec 2018 low did not reach the lower trend line at about 2250.  This was one of the reasons I called for a bottom in Dec 2018 around 2350, since most analysts called for a low near 2250 once the Feb low of 2500 was broken.  Many times popular targets become "fake outs" and markets turn prematurely.

Next, a look at the long term CPCE from Stockcharts back to 2003 charted as 1/CPCE for consistency with the "spread" chart also using 10 day SMAs, you can see the LT upward trends normally coincided with low CPCE (or high 1/CPCE).  My conclusion considering all other sentiment is that we are approaching a top similar to July 2007 where there will be one or more (SPX 2015, DJIA 2000-2001) retests of the high before rolling over with an eventual decline to the low SPX 2000s.  Other sentiment includes the Safety Trade Indicator shown above (SPX/TNX ETFs) that is now on a BUY while several months of SELLs were seen mid-2018 before the Q4 selloff and the LT $NYUPV/$NYDNV that remains in consolidation mode similar to 2016 rather than the sharp downturn (100 SMA, red) seen before the Aug 2017 and Oct-Dec 2018 declines.

Conclusions.  Overall, INT sentiment is becoming downright scary with consistently lower bearish levels than seen over the last two years, but this is what should be expected if a larger 30%+ decline were likely.  I remember a couple of years ago when I used a select group of indicators to look at the 2007-09 period, and bearish sentiment was lower on May of 2008 at DJIA 13K than it was Oct 2007 at 14K.

ST, however, more upside seems likely.  The VIX Call Indicator is warning of a downturn that may be two to three weeks away.  A new indicator using the Equity P/C to combined P/C spread shows that smart money is still buying equity calls, while trend lines are showing that major resistance resides just above SPX 3400.

LT, we may be at the cusp of a moderate bear market with the potential for a 30-40% correction that could see multiple high retests of the highs (while Safety Trade remains positive) and stretch over a couple of years similar to the DJIA from 2000-2002.  I doubt if there is a repeat of the tech disaster, but if further confrontation with China leads them to place restrictions on the export of rare earth elements (retalation to Huawei ban), it would cause major disruptions in the the tech sector.

Weekly Trade Alert.  Uncertainty over the markets reaction to Trump's impeachment as well as mixed ST sentiment makes up/down a 50/50 call.  A continued rally, which seems likely, increases the likelihood of a negative reaction with problems for Trump surfacing in the impeachment process, while a pause may be a setup for a final fling if he is cleared.    Updates @mrktsignals.

Investment Diary,  Indicator Primer,  update 2019.04.27 Stock Buybacks, update 2018.03.28  Dumb Money/Smart Money Indicators
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